Our Plan for Reviving Spain

Fiscal consolidation must be matched with bold structural reforms to foster growth.

By

Luis de Guindos

Updated Jan. 19, 2012 5:44 p.m. ET

The current financial crisis has hit some countries more deeply than others—Spain among them due to our domestic imbalances. We perfectly understand the reasons our country has been brought to the outrageous situation of having the highest unemployment rate among developed economies: 22.9% as of November. Consequently, we also know which measures need to be urgently adopted to take back our economy and generate stable employment and sustainable growth, and we know the short-term adjustment costs we will have to pay to achieve it. More importantly, we have a mandate from our citizens to do whatever it takes to fix the situation once and for all.

ENLARGE

Luis de Guindos, Spain's economy minister.
Bloomberg News

The Spanish people, the national and regional governments, and all significant players in Spanish society are fully aware of how crucial the coming months will be to our future and to the European Union as a whole. The task to be completed is ambitious. On the one hand, we have to keep pushing the fiscal-consolidation measures we have already started to meet our public-deficit targets. On the other, we have to foster growth through the introduction of bold structural measures.

Fiscal consolidation is not a choice. It is a requirement to guarantee investor confidence in the sustainability of our public accounts and in Spain's macroeconomic stability, and thereafter to enjoy a reasonable cost of borrowing for both the public and private sectors. This is why the first decision made by Prime Minister Mariano Rajoy's new government, just a week after taking office in November, was to implement a harsh package of expenditure cuts and a progressive increase in the income tax. These measures were necessary to offset the impact of the unexpected jump in the 2011 public deficit to 8% from the 6% originally forecasted.

ENLARGE

Prime Minister Mariano Rajoy
Bloomberg

These measures, though unpopular and unwanted, have had the endorsement of the majority of our parliament. The Spanish parliament was among the first in Europe to introduce a constitutional change to limit budget deficits. This decision was agreed upon in September last year with the full support of the People's Party, which was on the opposition benches at that time.

A law enforcing this principle will be enacted before March 31. This law will set expenditure ceilings for all public entities, including the Estate Administration, the Autonomous Regions and major city halls. The entire public sector will not be allowed to run structural deficits of more than 0.4% of GDP or accrue debt of more than 60% of GDP. Spain will therefore be among the first EU members to introduce in its domestic legal framework the economic governance agreements just reached at the EU.

Structural reforms will be essential to offset the impact of the fiscal consolidation measures on growth. Within a monetary union, they are the main instruments national authorities have to foster growth and employment. Among these reforms, those overhauling the labor market and the financial system will be decisive.

The new labor-market reform will pursue a simple but critical target: to foster job creation and productivity in order to enhance the competitiveness of Spanish companies and of the economy as a whole. To achieve this goal, the reform must be comprehensive and tackle the main flaws in the present labor market.

First, our wage-bargaining system needs to be deeply revised to allow for an efficient and non-inflationary mechanism based on productivity gains. In Spain, we have inherited a very centralized wage bargaining system that establishes salary increases at the sector level. This system has proved to be one of the main reasons for the loss in competitiveness we have suffered during the last decade.

Moreover, the wage-bargaining system does not take into consideration productivity gains or companies' need to adapt to a changing and unpredictable environment. Wage bargaining needs to be done at the level of individual firms. We need to implement a completely new framework suitable for small and medium enterprises, which currently represent 80% of total employment in Spain.

Second, we currently have around 40 different types of employment contract. This has to be simplified: one unique full-time contract with common clauses for all new workers, and another to encourage part-time hiring.

Third, we need active labor-market policies both for the unemployed and for current workers will have to be overhauled to foster productivity and to allow the reallocation of human capital to high-value-added sectors.

Regarding the financial system, we need new momentum behind restructuring the banking industry. We must accelerate, in a conclusive and transparent way, the correct valuation and cleaning-up of financial institutions' balance sheets.

The new financial reform we will launch shortly will oblige banks to increase their provisions sufficiently to cover any writedowns that may emerge on their real-estate-related assets and loans. Taxpayers' money will not be used to finance the additional regulatory requirements arising from the reform. All the funds implied will have to come from the system's own internal resources. Institutions unable to fulfill the new requirements will be encouraged to merge with other players through a properly designed incentive system.

Overall, the new regulatory measures will foster transparency and solvency. They will generate efficiency synergies and adjust capacity in the banking system to meet new market conditions. The result will be fewer but stronger players, more accountable institutions, and enhanced corporate governance.

Needless to say, Spain will continue to act as a cooperative and loyal member of the European Union. The reforms I have described are fully consistent with the new economic governance framework that is being agreed upon at the EU level.

The work to be done during the next months is enormous—not even taking into account other reforms we are planning, such as ones in education or the justice administration. Fortunately the new government has what's necessary to succeed. The People's Party sorted out another gloomy macroeconomic situation back in the mid-1990, making it possible for Spain to join the euro in the first round. Prime Minister Rajoy's government enjoys vast popular support both at the national and the regional level, and it has four years ahead of it to make change happen.

We also have the determination to do what is needed. Though the task is ambitious, it is manageable. We are convinced that by deploying the plan I have outlined, we will regain markets' trust. We fully believe we have a unique opportunity to regain the prosperity that we should never have lost.

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